Low bond rates hit company balance sheets

International accounting standards mean that without a “deep, active, high-quality and liquid” local corporate bond market, Australian companies have to calculate their long-term liabilities at a higher rate. Illustration: Rocco Fazzari

Sally Rose

The debate about whether Australia has a deep and liquid corporate bond market has become more urgent – it could shave millions of dollars off the liabilities of our largest companies.

Peak body for chief financial officers, The Group of 100, is asking the global accounting standards setter to clarify when a local corporate bond market is liquid enough to allow companies to use corporate interest rates to discount future liabilities.

The call, which has the support of major accounting groups, has been prompted by plunging government bond yields. Because these are used as the discount rate when calculating the present value in company accounts, the lower government bond rate has increased long-term employee liabilities, such as pensions, carried on corporate balance sheets.

Under international accounting rules, companies can only use the local corporate bond rate to discount future cash flows when there is a “deep, active, high-quality, liquid corporate bond market”. In the absence of that, as is the case in Australia, the relevant government bond rate must be applied. But the gap between the Commonwealth rate of about 3 per cent and what large Australian companies can borrow at – about 7 per cent to 8 per cent – has widened as investors have accepted lower rates for bonds they consider to be safer. The impact of the gap is profound: the present value of $100 10 years in the future is $74 using a 3 per cent discount rate, but only $50 using a 7 per cent rate. Using a higher rate allows companies to reduce the level of liabilities on the balance sheet.

Companies in the US, UK, Canada and the euro zone can all calculate the discount on their employee liabilities using corporate bond yields, which are significantly higher than their respective government bond rates.

Australian organisations including Qantas Airways, Telstra Corporation, Commonwealth Bank of Australia, Australia Post and AMP have reduced the impact on their liabilities by using state government bond rates, which are higher than the government rate.

“Deep” refers to how many companies are issuing. A big increase in the number of Australian companies issuing over the past year, especially compared with a slowdown in the number of issuers in some other markets, adds weight to the push for a review.

“Active” refers to how many people are trading and “liquid” the frequency of trading. On these measures the local corporate bond market is non-existent.

But there are moves to kick-start the market including a government initiative to stimulate the retail bond market and plans to begin trading Commonwealth bonds on the Australian Securities Exchange in early 2013.

“High quality” is typically characterised by a AA or higher rating. The Group of 100 wants this dropped to an A rating. BHP Billiton and Woolworths both issued A-rated bonds in the past year and few accountants would argue such blue-chip companies should be excluded. Some suggest the ratings benchmark could go lower. Sometimes BBB-rated companies issue bonds at similar prices to those with an A rating.

The short duration of the Australian market is another impediment. Ten-year corporate bonds are a rarity in the local market, where very little debt is issued beyond five years.

Another big question is exactly what structures can be considered part of the corporate bond market. Vanilla fixed-rate corporate bonds are the obvious choice, but in some countries covered bonds, asset-backed securities and mortgage-backed securities are also included. Good-quality subordinated notes might also be included, although auditors say these are unlikely to be of high enough quality.

Even if a more liberal understanding of what constitutes a deep, active, high-quality and liquid local corporate bond market is reached, it will still likely take a number of years before Australia has one.